2021 Grains Outlook Part IV - Geopolitics, The Dollar, and Inflation

2021 Grains Outlook

The Big Shift

Part IV - Geopolitics, The Dollar, and Inflation

International Relations and Trade

While weather may be the critical factor impacting grain prices in the year ahead, one cannot overlook the potential impact of geopolitics.

During the spring of 2020, wheat prices outperformed stocks as consumers and nations alike rushed to procure pastas, breads, and wheat. Russia, in an attempt to shore up their domestic supply, signaled that they would be capping their exports. This was a significant development for wheat importers and highlighted the need for sovereign nations to fortify both their food stocks and their international supply chains for all grains.

Case in point, a portion of Chinese grain purchases, including corn, soybeans, wheat, and rice appears to be tied to an effort to restock and increase domestic grain reserves. China’s consumption needs and/or its desire to stockpile grains inextricably ties China to the US and other global grain exporters for the foreseeable future. While the relationship between China and the US is volatile, we do not see a scenario where the Chinese can turn away from American grain markets any time soon.

China accounts for approximately two-thirds of the world’s global soybean imports. Recall that the US and Brazil account for over 85% of global soybean exports. The US, Brazil, and Argentina are three of China’s largest markets for soybeans. China would not be able to meet its soybean demand without these three countries. What’s more, Brazil recently purchased soybeans from the US. Presumably, Brazilian farmers have “oversold” their crop and are importing in order to meet domestic demand. The point here is that China needs US soybeans, and they will likely continue to purchase from the US regardless of political tensions.

A Weakening US Dollar

Having recently dipped to around 90, the Dollar Index (DXY)[1] is now approaching 5-year lows around 89.

Chart 14

Chart created by Teucrium using Bloomberg Finance LP on 12/19/2020

Dollar Index (DXY) Weekly Price Chart 12/31/2015–12/18/2020

Past performance is not indicative of future results

We see a weakening US dollar as providing additional incentive for China and other countries to purchase US grains. A weak US dollar has historically been a tailwind for US grain exports as well as for global grain prices. The dollar/grain commodity relationship is relatively straightforward. Globally, commodities are priced in dollars. A weakening US dollar means that commodities in general, and US exports in particular, become more competitive relative to other non-dollar currencies. For example, if the US dollar depreciates against the euro, then it will take fewer euros to purchase the same amount of goods priced in dollars. All else being equal, the increase in demand for dollar-denominated US goods would generally be supportive of prices.

While the Dollar Index (DXY) provides a quick read on dollar strength/weakness, the dollar/real and dollar/ruble currency pairs are more important indicators relating to global grain prices. Historically, global soybean prices have moved higher as the dollar weakens versus the Brazilian real because Brazilian soybean farmers are less likely to export soybeans versus selling soybeans domestically.

Chart 15

Chart created by Teucrium using Bloomberg Finance LP on 12/22/2020

Front Month Soybean Futures vs USD/BRL Currency Pair

Monthly Price Chart 12/31/2015–12/18/2020

Past performance is not indicative of future results

The same relationship exists between the dollar/ruble currency pair and US wheat prices. Note, however, that the US is among a handful of large global wheat exporters. While a weaker dollar vs. the ruble makes US wheat “cheaper” vs. Russian wheat, global importers still have a multitude of options. Even so, given that Russia is the world’s largest wheat exporter, dollar weakness against the ruble is seen as being supportive for global wheat prices.

Note that the USD is simultaneously weakening against currencies of some of the world’s largest wheat exporting nations. The US dollar declining across the board could provide a tailwind for global wheat prices.

The world’s top wheat exporting nations according to the USDA are as follows: Argentina, Australia, Canada, European Union, Russia, and the Ukraine. The appreciation of the USD vs the Argentinian peso is beyond the chart and is not depicted in Chart 16. Argentina is the smallest of the seven major global wheat exporters.

Chart 16

Chart created by Teucrium using Bloomberg Finance LP on 12/22/2020

USDCAD, USDEUR, USDUAH, USDRUB, USDAUD Currency Pairs

Monthly Price Chart 12/31/2015–12/18/2020

Past performance is not indicative of future results

Inflated Inflation Expectations?

Many are pointing to the unprecedented US fiscal and monetary response to the COVID-19 pandemic as the key driver for a weaker dollar globally. Additionally, market participants seem to be increasingly weary of the potential for inflation in the US. Caution is warranted, however, as we do not believe that security purchases by the Federal Reserve (i.e., Quantitative Easing or QE) alone are enough to spark broad based inflation in the US.[2] Consider that 12 years after QE 1 was announced, headline CPI remains below 2% year over year.

We do think inflation concerns are warranted when considering the Federal Reserve’s potential to adopt Modern Monetary Policy combined with fiscal experimentation with some level of Universal Basic Income. The combination of these two policies would amount to something new that we will call Monetary Spending.[3] Monetary spending could lead to a scenario where demand for consumer goods outpaces the supply of those goods thereby sparking broad based inflation.

More immediately and far more likely in our opinion, is the effect rising crude oil and natural gas prices will have on future moves in headline inflation. New policy shifts in the U.S., and indeed throughout the globe, toward the “greening” of the current carbon-based energy industry will accelerate the already developing inflationary trends in crude oil and natural gas. New administrative, environmental, and tax policy burdens that disincentivize the production of fossil fuels will cause crude oil and gas prices to rise, raising overall inflation rates across the globe. In the end, this could create more demand for grains via increased usage of alternative fuels like ethanol and biodiesel.

While broad-based inflation would likely provide an additional tailwind to grain prices, food prices are already running far north of headline CPI. As of November 30, food prices are up 3.94% year over year versus a headline CPI of 1.175%.

We believe investors who are actively positioning their portfolios for future inflation might do well to consider current opportunities in grains, especially if the trend of a weaker dollar continues well into 2021.

Additionally grains historically have low correlations to equities, and offer the potential to improve portfolio outcomes during periods of stock market volatility. We discuss these potential diversification benefits and conclude with a summary of the Big Shift in Part V of our 2021 Grains Outlook.

Stay tuned...

[1] DXY Index component weightings: Euro 57.6%, Japanese Yen 13.6%, British Pound 11.9%, Canadian Dollar 9.1%, Swedish Krona 4.2%, Swiss Franc 3.6%

[2] Quantitative Easing: “A form of monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment” - https://www.investopedia.com/terms/q/quantitative-easing.asp

[3] Monetary Spending: a process by which newly created Federal Reserve Notes are deposited with the US Treasury to fund direct payments (i.e., stimulus checks or “basic income”) to individual consumers.